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Wednesday, September 24, 2008

The Bailout is Not About Fat Cats on Wall Street

I recently tried to explain the importance of the financial crisis to a bailout-skeptical friend, who is a medical doctor, with these words:

Let me put it this way: how would you feel if you woke up tomorrow and found you couldn't use your credit or debit card and couldn't access the funds in your bank account in any way? Or consider how long your hospital could function if it could not tap into its lines of credit or access its funds. Just go and ask your hospital CFO. More generally, the real side of the economy--the side where goods and service get produced--would come to a grinding halt if credit stopped flowing. This has become a real concern lately.

I think this is a point that many people miss. Our economy is so incredibly dependent on a smooth functioning financial system that its absence would devastate our day-to-day lives. Yet many people fail to appreciate this dependency and thus find it hard see the importance of stabilizing the financial system. What they see instead is the bailing out of Wall Street Fat Cats.

Now one can question the details of the proposed bailout, but that is a different issue. One can also raise questions about moral hazard, but at this juncture any moral hazard concerns are dwarfed by the threat of financial system meltdown. This intervention is all about maintaining our financial system. Bloomberg's John Berry argues this very point:

In the days since Treasury Secretary Henry Paulson released his $700 billion plan to restore stability to financial markets, the essential point has been lost in all the complaints about bailing out banks and greedy executives.

Why should such institutions be helped when ordinary American taxpayers -- who have managed their own finances prudently and are being battered by a loss of wealth and jobs -- have to pick up the tab?

Because there's no choice.

The fuss about the purpose of the plan and the sense that it was really just intended to help a bunch of fat cats had reached a point that Federal Reserve Chairman Ben S. Bernanke, testifying yesterday before the Senate Banking Committee, stressed that he was a college professor, had never worked on Wall Street and had no connection to it. His only concern, he said, was the future of the economy.

The credit markets are in a ``fragile condition'' and not functioning properly, Bernanke said. If no action is taken, more jobs will be lost, more houses foreclosed and the economy will contract because credit won't be available.

``There will be significant adverse consequences for the average person in the United States,'' Bernanke said.

3 comments:

Your point that credit is critical to the real economy is correct.Which makes it only the more amazing to me that currently popular macroeconomic models that economists use treat intermediation in such a desultory and simplistic way. The money supply (whatever that is) is a summary statistic for the whole plumbing network. (The only exception I can think of is Tobinand Brainard, but who reads them?)

On your wider point, first, the language matters. (Deidre McCloskey has spent 2 decades ramming home that point.) Calling it a bailout prejudices our viewpoint, skewing us precisely to think of helping fat cats.So I choose the more neutral government intervention.Second, the details matter tremendously. Perhaps the Swedish model offers some guidance. This ruthlessly wiped out the shareholders and executives. Punishment is important, as well as rescuing the system. Desire for Fairness is a basic human trait. No question that the original administration plan violated that. And was bad economics to boot.There are better ways, and there is a list of highly-regarded economists opposing the plan up on John Cochrane's website

Yes, the use of the word bailout is unfortunate. However, it is the term being used by most observers in the debate so one has to start there to connect with the masses.

I agree with your second point too...the devil is the details. I would refer others to you or other commentary on the web (see Krugman and Mark Thoma). They have far more wisdom on these matters than me.